Sitharaman must come out clean on fiscal deficit number

The lenders’ cry and the Centre’s concern over the poor monetary transmission of the Reserve Bank of India’s interest rate cut! An age-old problem for which one holds the other responsible may have an answer in the RBI Deputy Governor Viral Acharya’s submission in the minutes of Monetary Policy Committee released last week.

Mincing no words, Acharya hit out at the Centre blaming its fiscal policy that keeps pushing expenditure off budget to meet the deficit target and then takes recourse to borrow from the national small savings fund. To keep doing that, the governments keep administrative interest rates high to incentivise such savings.

“This impedes monetary transmission. Poor monetary transmission requires a more active fiscal policy to compensate which breaches fiscal targets once again,”, said Acharya. A message for Finance Minister Nirmala Sitharaman, who is set to present her first Budget on July 5.

India, the world’s fastest growing major economy, has fallen with a thud. All of a sudden, there is bad news from every corner. Gross domestic product growth has dipped to a little above 5.5% and the escalating trade war has dimmed the prospect of growth going forward, investment is slowing and people have little money to spend on their discretionary purchases. And as if it were not enough, the renewed US-Iran tension has sent the crude oil prices soaring, which have raised the spectre of rupee getting depreciated further against the US dollar.

Disaster awaiting

A perfect recipe for macro-economic disaster is awaiting the finance minister. Crude oil and rupee are the two big factors that impact the macros of India and both were on the ebb in the past as many weeks but now they appear to be a bigger worry than trade war.

In this scenario, what should Sitharaman do to lift the economy of a slowdown? If she gives a tax break and announces higher spending to boost consumer demand, her Budget math could go into a disarray. The fiscal deficit will rise crowding out private investment, jacking up interest rates, increasing inflation, impacting exports and finally leading to higher taxes for citizens.

If she tries to keep a lid on the fiscal deficit, government spending will be constrained, consumption will suffer and India’s demand-driven economy could take a further hit. Fiscal deficit arise when a government spends more in a fiscal year than it earns. Incurring such a deficit is not bad if the government spends on infrastructure and lends to businesses to boost economic activities but it arises if the receipts of government have fallen through tax cuts or falling business activities, then it is worrisome.

In India’s case, it is often the subdued tax receipts that inflate the fiscal deficit. The tax-to-GDP ratio in the country is so low that the government is perennially under loss. Despite the best efforts, India’s fiscal deficit is at 3.4% of the GDP. Now, the chances are that the finance minister may breach the sacrosanct number this time around. Heavens would not fall if its breached by a percentage point or two. The markets have priced that in. But the expenditure should be channelled to productive usage and not in expenses like writing off loans to the farmers or hiking subsidies or lowering tax rates for a certain section of people. This is popularly known as the quality of fiscal deficit. Markets -- stock, bond and money -- are perfectly okay if the money is lent to businesses to expand.

In all probability, the FM may also extend the FRBM (Fiscal Responsibility and Budget Management) deadline that targets 3% fiscal deficit by 2020 to a couple of years more. In 2016, the government had set up a committee to review the FRBM Act. The committee recommended that the government should target a fiscal deficit of 3% of the GDP by 2020, 2.8% in the following year and 2.5% by 2023.

But, all that the stakeholders would want on July 5, is a clarity on the number and not just the headline number but also the breakup math. Last month, a dozen economists in their meeting with the 15th Finance Commission had suggested that the government should not Budget a lower fiscal deficit knowing fully well that they cannot achieve it. They had also warned on excessive off-Budget spendings such as accessing money from small savings or asking state-owned enterprises to pay for the government’s subsidy bills. These tactics allow the headline fiscal deficit number look decent but raise questions on the credibility of Budget maths.

RBI’s Acharya also suggested that estimates of overall public sector borrowing requirement – which appropriately accounts for extra-budgetary resources and other off-balance sheet borrowings of central and state governments –have now reached between 8% and 9% of GDP. This is at a level similar to that in 2013 at the time of the “taper tantrum” crisis. It is alarming.